Question $3$

Gourmet Bakery Co plans to buy a new baking machine. The cost of the baking machine,

payable immediately, is $$800,000$ and the machine has an expected useful life of five

years. Additional investment in working capital of $$90,000$ will be required at the start of

the first year of operation. At the end of five years, the baking machine will be sold for

scrap, with the scrap value expected to be $5\%$ of the initial purchase cost of the baking

machine. The baking machine will not be replaced.

Production and sales from the new baking machine are expected to be $100,000$ units per

year. Each unit can be sold for $$16$ per unit and will incur variable costs of $$11$ per unit.

Incremental fixed costs arising from the operation of the baking machine will be $$160,000$

per year.

Gourmet Bakery has an after$-$tax cost of capital of $11\%$ which it uses as a discount rate in

investment appraisal. The company pays profit tax one year in arrears at an annual rate of

$20\%$ per year. Capital allowances and inflation should be ignored.

Required:

a$)$ Calculate the net present value of investing in the new baking machine.

$(10$ marks$)$

b$)$ Calculate the internal rate of return of investing in the new baking machine.

$(5$ marks$)$

c$)$ Advise whether the investment is financially acceptable.

$(3$ marks$)$

d$)$ Critically analyse why NPV is the most superior investent appraisal technique.

$(7$ marks$)$

Total $-25$ marks